Return of the J.E.D.I.

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Disclosure: The following represents my opinions only. I am long TAO.V, TNZ.TO, and VLE.TO (Image credit to Pawel Nolbert on Unsplash)

Long ago, in a far away galaxy, investors once cared about junior international energy stocks. There was a diverse ecosystem of analysts and institutions investing in international energy stories as the world demanded more oil in response to the massive growth in Asia, particularly China. There was a whole sub-sector of international Canadian-based independent champions in just about every major oil producing region you can think of, and the shares were widely owned and traded by institutions and retail investors alike. Financings were announced and oversubscribed, capital was deployed, risks were taken. Fortunes were made and lost, and through all of it, more oil and gas did make it to market as a result. After the 2008 implosion, gradually, the light faded; and eventually only a shadow of the sector and its investors remained. Now, fifteen years after the GFC, I’m feeling like 2023 could see the return of the J.E.D.I. — the Juniors who Explore and Develop Internationally — in terms of small cap market interest. In Q4 alone, I have seen Jedi-like deals for three of my junior hopefuls — Tag Oil (TAO.V, last at $0.55), Valerua Energy (VLE.TO, last at $1.70), and now, Tenaz Energy (TNZ.TO, last at $2.00). I think that all three of these companies have the ability to inspire hope in a sector that has been lost for years… and they all will begin their journeys in earnest in the New Year.

Tenaz is the the most topical today, since they announced their entry into the Dutch North Sea less than 24 hours ago. The deal isn’t that big, adding about 5 million cubic feet per day of gas to TNZ’s production base from a private company seller, but man is it accretive on a per share basis — and this is just the ‘ante’. The press release suggests that this deal is indicative of where the market could/should expect to see TNZ focus some its attention in terms of future acquisitions as Tony Marino and his team continue on their quest to build a 50,000-100,000 boepd company.

TNZ’s deal reads as a “starter kit” — though it includes pipeline interests, production, and a future carbon-storage project too boot — and savvy readers will have noticed that (a) the asset purchase has already closed, and (b) it was fully funded without issuing a single share of equity — meaning that TNZ as just increased 2023 cash flow per share from around $0.50/share to about $1.30/share. That means that at yesterday’s closing price of $2.00, TNZ is trading at around 1.5x EV/CF on 2023 numbers… I’ll let you decide if a 1.5x EV/CF is an appropriate multiple for a company that just grew its cash flow per share by 160% in its first deal. If you’re starting to wonder if the last two sentences are typos. They are not… this is the beauty of pristine capital structure and the resulting per share leverage. TNZ has just a little over 28 million shares outstanding — with no warrants, and only a modest option pool — which means that today’s 25% jump in the share price increased TNZ’s market cap by just $11 million. Before today’s deal, I had outlined what I thought was a very defensible fair value of $2.50/share for TNZ, and the stock isn’t even at that level yet, so I think the value argument just got much more compelling. With TNZ’s unrelenting focus on generating value per share, I’m quite content to wait to see what additional deal flow in 2023 will bring as management executes on their acquire-optimize-develop strategy. Magical things can happen when a good management team is given a clean balance sheet, a tight capital structure, a fertile deal environment, and a little bit of time. Sometimes, it just doesn’t need to be more complicated than that.

I wrote recently on Valeura’s new deal and I don’t have much new to add, but I can summarize my understanding of what 2023 looks like for the company. According to UK-based Stephane Foucaud at Actus Advisors, VLE would end 2023 with some US$200 million of cash in the bank based on a $100/bbl average 2023 Brent oil price (Stephane has a C$4.50 target on VLE). I know that may sound like a bit of a stretch on Brent crude prices, but even at $80/bbl, VLE’s YE2023 net cash number would be at least US$100mm by my envelope math, which is roughly equal to the company’s current market cap. With multiple opportunities to extend the lives of the acquired fields (by several years at least) through additional drilling, VLE thinks it can bring big dollars to the bottom line in the process — and defer decommissioning — as its annual cash flows are substantial. The acquisition is expected to close in mid-February, and cash flow from the operations has been piling up in escrow since Sept. 1, 2022; meaning that there will likely be a nice accounting adjustment on closing. An updated comprehensive reserves report should be available by late February-March which will be enlightening. VLE’s deal continues to mystify anyone who looks at it, but from my work on it, it really does look that good. VLE has a good capital structure with 86.6 million shares outstanding, with a modest option pool, and no warrants. UK-based Baillie Gifford remains VLE’s largest shareholder. The company plans to market the deal more actively in Q1, so, despite the move in the stock, I think the market is still in the “discovery phase” on this one. VLE could exit 2023 at 25,000-30,000 bopd…

I’m short on time, but Tag Oil rounds out my holy trinity of JEDI stocks for 2023. The vertical well re-entry and frack of the ARF formation is expected to get underway in mid-January and should take about 15 days in the field, followed by 30 days of production before news on the well is released. TAO will begin with a well that intermittently produced a total of 20,000 barrels of oil decades ago, so there is zero doubt that there is oil at this location. The only question is what it will flow after it’s fracked and what kind of IP30 (first 30-day flow) rate the well will deliver. TAO is loaded with cash and has its ducks in a row in terms of how to unlock the value of the ARF play, so once this story gets rolling it should gather steam like a snowball rolling downhill. The vertical test rate will be very informative for the horizontal well that is to follow, both of which would set the wheels in motion towards a >50++ million barrel recoverable resource with success. First things first though, let’s see that vertical test — fortunately the wait won’t be long.

All three of the above names are small in terms of market cap. Tenaz’s market cap is just $56 million, Tag’s is around $80 million, and Valeura weighs in at about $145 million. Despite their small statures, I believe that all three have the potential to inspire investment in the junior international sector at a time when the majors are leaving a void in non-core optimization, exploration, and development projects. As a guy who invests in mining a lot, I continue to be mystified by the valuations that the market will pay for mining assets that have no hope of producing a dime of cash flow for 5-10+ years if they are lucky, while a story like TNZ sits at 1.5x EV/CF, but that’s the market for you. In that context, I think my holy trinity of international juniors represents a very interesting type of value proposition if I’m patient. I fully believe that any or all of these companies could carve out $500+ million market caps with market support and solid execution. Will 2023 see the return of the JEDI? Time will tell, but I think that the odds look good.

May the force be with you.